Executive Summary
Enjoy the current installment of "weekend reading for financial planners" – this week's edition kicks off with the news that the CFP Board has selected Vanguard veteran Jack Brod, CFP, to serve as President-Elect of its Board of Directors, as Vanguard itself becomes a rising force in hiring CFP certificants for its Vanguard Personal Advisor Services division (which Brod helped to establish), and the CFP Board may face new struggles during Brod's Chairman year in 2020 when the organization will have to actually begin enforcing its new fiduciary Standards of Conduct for the first time.
There were a number of other big news items this week as well, including a new set of retirement plan proposals rolling through Congress (that appear to have a chance to pass) that would expand multi-employer plan (MEP) options for smaller 401(k) plans and make it easier for 401(k) participants to buy (immediate) annuities at retirement, the revelation that, with its final IPO under two weeks out, Focus Financial's opening price may come in substantially higher than previously anticipated (suggesting there is still substantial investor demand for RIAs and potentially fueling a fresh new wave of M&A), and the finalization of New York state's fiduciary rule for annuity and life insurance sales (which could prove to be an industry-wide template if the NAIC does not implement a similar model rule).
From there, we have a number of articles on next generation advisors, succession planning, and continuity planning, including: the generational perspective gaps that are impeding the ability of founders and successors to establish effective succession plans; why next generation advisors want more than a job (and how to inspire them to come into the financial planning profession); issues to consider when implementing a real-world succession plan (from both the founder-owner and successor-owner's perspectives); the tax-related considerations in how a buy/sell agreement or succession plan is structured; and how to properly structure a continuity plan for those who do not want to retire and transition to a successor but do need a contingency plan for what happens to the business and their clients if something happens to them (e.g., in the event of sudden disability or death).
We wrap up with three interesting articles, all around the theme of how financial advisor and financial advisors are changing in the future: the first explores the rise of financial wellness programs in the workplace, as employee research finds that financially-related issues cause so much disruption in the workplace that employers can get a positive ROI by subsidizing or even fully paying for financial wellness programs for employees, spawning not only a growing volume of financial wellness technology platforms, but even a rise in human financial advisor solutions offered in the workplace channel; the second looks at how nearly 5 years ago Australia set the template for fiduciary reform by being one of the first major countries to ban commissions for financial advisors, but the fact that those advisors remained employed by the companies that manufacture and distribute product has left them so conflicted that a Royal Commission is now investigating and deliberating about whether to split advice and product sales entirely (in a move that again could become a template for reform around the globe); and the last looks at how, despite the industry's efforts to improve gender, age, and ethnic diversity, the needle has barely moved in years, raising the question of whether the problem is simply a lack of awareness and diversity support programs, or if the industry's traditional view that "Financial success is derived from having a fixed set of goals funded as a consistent percentage of income into stock-market-based accounts" (based on our investment-centric business models) could unwittingly be less appealing and less aligned to the real-world needs and views of women, Millennials, and people of color, who may approach their own financial goals and saving and investing philosophies differently?
Enjoy the "light" reading!
CFP Board Taps Vanguard Veteran To Head Board Of Directors At A Critical Time (Kenneth Corbin, Financial Planning) - This week, the CFP Board announced that Vanguard veteran Jack Brod has been selected as President-Elect of the organization's Board of Directors. Brod was a long-time executive at Vanguard who recently retired from the organization, is a CFP certificant, and was the one who launched both Vanguard Asset Management Services (which ultimately became Vanguard Personal Advisor Services with hundreds of CFP certificants), and helped to restructure (and rapidly grow) its Financial Advisor Services division over the past 7 years. In his role as President-Elect of the board, Brod will become even more deeply involved in setting CFP Board strategy, at a time when both the industry and organization and in the midst of significant change, with the CFP Board's updated fiduciary Standards of Conduct taking effect next October of 2019 (which means they will have just taken effect when Brod enters his Chairman year of leadership in 2020), when the CFP Board will have to first start enforcing its new rules. And given Brod's deep experience in the mega-firm environment, where fiduciary CFP compliance is likely to be messiest, arguably he will be bringing the right expertise at the right time for the CFP Board to hold fast to its new higher standards.
Retirement Bills In Congress Could Alter 401(k) Plans (Richard Rubin & Anne Tergesen, Wall Street Journal) - The Republicans are gearing up for another round of tax legislation this summer and fall (dubbed "Tax Reform 2.0"), and there is growing bipartisan support to push through new initiatives specifically targeted at encouraging retirement savings. At this point, there are a number of different proposals spanning both the Senate and House, so it's unclear which version(s) will ultimately gain traction in the legislative proposal, but possibilities being considered include: making it easier for small businesses to establish multi-employer plan (MEP) arrangements to reduce administrative costs and improve bargaining power to negotiate lower 401(k) fees (without otherwise having any affiliation or connection as is required for current MEPs); easing small business automatic enrollment for employees into 401(k) plans, and making it feasible for them to have automatic escalation clauses that could eventually lift employee savings rates higher than 10% (the current cap); a reporting change that would require 401(k) plans to start giving employees quotes on their statements about the monthly annuity income their savings would support in retirement, and an adjustment to the liability rules to make it easier for 401(k) plans to offer annuities at retirement; an increase in the small business tax credit to start a retirement plan (from $500 now to as much as $5,000 over 3 years); the ability to continue to contribute to a traditional IRA after age 70 1/2 for those who are still working; a new form of short-term savings account to help with financial emergencies; and a proposal to increase the SIMPLE IRA limits from $12,500 to $15,500 (and increase the catch-up limits from $3,000 to $4,500) with an option for even higher limits for businesses with 26 to 100 employees. The primary legislative proposal at this point in the Senate is dubbed the Retirement Enhancement and Savings Act (RESA), and already has both some bipartisan support and support from the industry and lobbying organizations like AARP, suggesting it may actually have a shot at passing this year.
Focus Financial IPO Is On At $39/Share As KKR Pushes Giant Share Premium (Brooke Southall, RIABiz) - In late May, Focus Financial announced that it intended to IPO, with a goal of tendering shares in the "low $20s/share" price, but with the final IPO launch looming (trading expected to get underway on July 30th under the ticker symbol FOCS), the price is coming in as high as $35 to $39/share (or a whopping 18X earnings!). The significance of this is not merely that Focus is using the opportunity to increase its own capital raise – upping the tranche of capital it seeks from $100M to more than $600M – but that it signifies what is still "pent-up demand" from large institutional buyers who want to invest into the RIA business model. On the other hand, if the price is merely being pushed up by investment bankers as a gambit, and FOCS falls back to the original $22/share range as was originally anticipated, it may be even harder for Focus to do equity-in-kind deals for new transactions; on the other hand, with the potential of raising $600M of cash, it may not need to either! In fact, the biggest significance of what appears to be a potentially-very-strong IPO for Focus is that the demand for RIA investing, coupled with Focus' newfound capital, may fuel even more buying and M&A activity for independent RIAs – both from Focus itself, and other M&A consolidators that will be willing to pay even more for large RIA firms (8X free cash flow, 9X, or even more?) if they see the potential for a public market exit at an 18X P/E ratio! (And may also help to explain why Emigrant Bank decided to announce a proposed sale of Mark Hurley's Fiduciary Network this week as well.)
New York Issues Final Best-Interest Regulation For Annuity & Life Insurance Sales (Mark Schoeff, Investment News) - This week, New York state issued its final regulations that would apply a best interests standard to the sale of annuities and life insurance in the state, raising the existing suitability standard of care (after first announcing the proposal last December). The move comes even as efforts to implement fiduciary rules in other states had recently begun to wane – ostensibly in anticipation of the SEC's new Regulation Best Interest proposal for brokers – though notably the SEC rule is only for investment products/brokers and thus doesn't overlap with New York's new regulation anyway. On the other hand, the National Association of Insurance Commissioners (NAIC) has also been working on updates to its annuity suitability rule that would lift the model regulation to encompass a Best Interests standard, although the NAIC proposal would only impact fixed annuities and not fixed life insurance products (e.g., indexed universal life). With the New York regulation now in effect, though, and with New York long recognized as a leader in state insurance and annuity regulation nationwide, the question arises as to whether states that have already shown an interest in better fiduciary regulation of advisors would even accept an NAIC annuity-only fiduciary standard, or use New York's rule as a model to lift the standards for annuity and life insurance salespeople.
Why Advisory Firm Founders And Successors Can't Get On The Same Page (Stephanie Bogan, Investment News) - The booming stock market of the past 10 years has brought most established advisory firms to new highs, just as the average age of the advisory firm owner approaches an age and stage where it's appealing to start slowing down and convert to more of a "lifestyle" practice. The good news of this shift is that the need for staff to support a less-active advisor/founder is fueling a new wave of hiring for associate planners and paraplanners in advisory firms; the bad news, however, is that many firm owners are struggling with the process of actually training and transitioning responsibilities to those next-generation advisors. The challenge is not merely one of founders "letting go", but that the generational mindset of next generation advisors is fundamentally different, as most of today's founders are self-driven/self-made entrepreneurs who built the firm by hand and got the clients one at a time, while newer advisors tend to have more professional degrees and designations and expect to join a service firm and not a sales force (as if they really wanted to go get clients, they'd simply start their own firm!). The end result is founders who fear their next generation advisors can't be the rainmakers and leaders that they were, and next generation advisors frustrated that their firm owners won't give a clear path to succession and don't understand their different perspective. Bogan suggests the starting point to rectify the situation is for founders to gain a better understanding of what next generation advisors actually want, and offer them the career opportunities that are mutually beneficial for the advisor and the firm, rather than simply trying to turn the next generation advisor into a "mini-me" version of themselves.
The Next Generation Of Advisers Don't Just Want A Job, They Want Inspiration (Janine Wertheim, Investment News) - As the AUM model continues to accumulate clients and compound growth over time, more and more advisory firms are discovering the challenges of the industry's shortage of next-generation talent, and are trying harder to figure out how to attract and retain them. Wertheim notes that part of the problem is that aspirational young people have a lot of choices, in a lot of different industries, which means it's not enough to merely offer them a job and a paycheck; instead, next-generation talent wants to pursue a cause they're inspired by. So how can advisory firms "inspire" their next generation talent? Wertheim suggests 4 core tactics: 1) provide them with positive role models early on, which means advisors getting more active in their schools and communities, especially given that one of the biggest blocking points in attracting talent to financial planning is simply that they aren't aware financial planning exists (as something separate/distinct from the broader financial services industry); 2) emphasize how being a financial advisor allows you to control your own destiny in the long run, both in terms of income and work/life balance, and the ability to express your own personality and values in the business you create and the way you serve clients; 3) enlist student's own "centers of influence" by connecting with professors and teachers, from visiting schools to announcing scholarship or internship programs; and help them feel more 'at home' in the industry by making your advisory firm more visible in your community so the idea of joining the business is not such a foreign concept in the first place. The key point, though, remains that it's not enough to offer next-generation talent a job; they're seeking an inspired career, which financial planning actually is, but the profession has struggled to make it apparent.
Share The Wealth: Considerations In NexGen Ownership (Rachel Moran, Journal of Financial Planning) - Despite the ongoing aging of advisory firm founders, there are still relatively few success stories of internal succession plans and effective transitions of ownership, management, and servicing of clients. Fortunately, Moran's firm RTD Financial has been able to successfully transition from the founder to a group of six successor owners, and notes several key decisions that helped to fuel the successful outcome, including that ownership was offered to key employees in the first 10 years to both seed future owners, and to build their own income streams to be capable of buying out the firm, and the shareholder agreement included a mandatory provision to sell shares upon turning age 70, which helped to introduce a natural partner progression and clarity for next generation advisors about when their opportunities will come (in a way that can be effectively planned for in advance). When Moran's own opportunity to buy in as a partner came, she considered several factors, including: due diligence on the firm's financials (do you understand the firm's financial statements, revenue history, and profit margins, along with its key client demographics like average age, average fee, average length of relationship, and its retention rates, and how those compare to industry benchmarking studies?); understanding the range of buy-in methods and valuation approaches (even if the firm's methodology is fixed, it's important to understand the mechanics), and don't be afraid to reach out to and ask peers who have been through similar transitions at other firms; and consider your own long-term career goals, and whether you're really on board with the company's vision and mission (and the partners you may be working with for a long time to come!). From the firm's perspective, Moran suggests that firm owners may underestimate the sheer size and magnitude of a "small" partnership stake (that could still cost more than the advisor's house) and emphasizes the importance of helping next generation advisors ease into ownership over time, while also pointing out that even advisors who historically have struggled to grow and "make rain" may become surprisingly motivated and step up once they actually feel like (and are) an owner in the business.
Evaluating The Tax Considerations In Buy-Sell Agreements (Bette Skandalis, Commonwealth) - While it's important not to let the tax tail wag the investment/deal dog, the reality is that advisory firms can be sold under many different types of terms and structures, which in turn can materially alter the tax consequences of the transaction. Broadly speaking, there are three different ways that sales (or buy-sell agreements) can be structured: a Revenue-Share sale, which is most common when selling a book of business, such as where the seller commits to pay the buyer a percentage of the revenues over a period of time (e.g., 50% of revenues for the next 4 years), but also means the seller receives the income as employment income, which means not only ordinary income tax brackets, but also self-employment taxes (though at least the income may also be eligible for the 20% QBI deduction for pass-through businesses); an Asset sale, where the original advisor sells both the tangible assets (e.g., office building, equipment, etc.) and the intangible assets (e.g., goodwill, employment agreements, etc.) to the buyer, where the price of the purchase is allocated between the two (which is important, because the purchase price allocated to goodwill is eligible for capital gains treatment to the seller, though it must be amortized over 15 years by the buyer); or a Stock sale that can apply if the advisory firm is structured as an S or C corporation, where the seller literally sells the stock in the business itself and receives capital gains treatment on the shares (though the buyer cannot amortize the price purchase the way he/she can with an asset sale). Notably, given that the varying tax treatment impacts both the buyer and seller, in practice negotiating the structure of the deal is relevant not only for the tax treatment itself, but because the tax treatment differences to the buyer and seller may change the purchase price itself, too.
Six Steps To Creating An Effective Continuity Plan (Marcus Hagood, FP Transitions) - While there is a growing focus on the fact that most advisory firms lack a succession plan, the reality is that many or even most advisors don't actually plan to retire out of the business soon anyway, in a world where it's feasible to continue working as a financial advisor well past the "traditional" age of retirement. However, even if the advisor doesn't need a successor because there's no plan to retire soon, it is important to have a continuity plan in the event of an unexpected and sudden disability or an untimely death. In this context, Hagood provides several best-practices suggestions in how to properly create a continuity plan, including: put the plan in writing (since you may not be there to explain it when the time comes!); include an industry-specific valuation (or directions for an appropriate third-party valuation firm) to quickly and accurately determine the value in the event of a hasty sale; be certain to define the term "disability" clearly in the agreement (as death is a clear trigger, but disability may be subjective, and often occurs gradually, which can make it difficult in practice to know when to pull the trigger); have plans for how to handle each partner in a multi-advisor firm (and especially if there are senior owners where there's a risk that multiple buy-outs could be triggered in quick succession); and be certain to review (and update if necessary) on an annual basis, as the needs of the business can and will change over time. And be aware that structurally, there are several ways to arrange a continuing agreement, from a simple revenue-sharing agreement (where the buyer agrees to pay the seller or the seller's heirs a percentage of the revenue for a period of years), to a "guardian" agreement where a designee can take over the client relationships immediately but specifies it is on a limited basis (a "guardianship" term) until the owner can return or the practice can be properly sold on the open market, and full-on buy-sell agreements that facilitate a formal and total change in ownership when the continuity terms are triggered.
The Next Frontier In Workplace Wellness Is Financial Health (Beth Pinsker, Reuters) - The latest PwC study on Employee Financial Wellness finds that nearly a quarter of U.S. workers state that their financial worries are causing them health problems, with 40% stating that their finances distract them at work and 15% reporting their financial woes caused them to miss work. These financially-related workplace disruptions have a real cost to businesses, and as a result more and more companies are providing a robust menu of voluntary financial wellness benefits, sometimes with cash incentives to encourage employees to take advantage of them. And the focus is not just on raising 401(k) plan participation, as the reality is that for workers experiencing absenteeism or health problems due to financial stress, the problem is rarely related to retirement savings and more likely associated with nearer-term present-day needs, from student loans to the need to refinance a mortgage or get tax assistance, or even offering an "advance payroll" service to reduce employees need to rely on expensive payday lenders. Notably, the starting point has been to leverage technology to deliver financial wellness programs, which can more easily be accomplished at scale for firms with hundreds or thousands of workers; yet at the same time, firms like Fidelity are increasingly offering face-to-face opportunities to meet with advisors, who go directly to workplace or other convenient-to-employees satellite locations, as human financial planning advice increasingly shifts to the employer channel.
The Future Of Advice [In Australia And Around The Globe] (Stephen Romic, Australian Journal of Financial Planning) - Several years ago, Australia implemented its "Future Of Financial Advice" (FOFA) reforms, that required advisors to act in the best interests of their clients, and largely banned commission-based compensation for advisors (although existing commission trails were grandfathered). But in the past year, a series of scandals has rocked the Australian financial advisor marketplace, driven by the recognition that when fee-only or salary-based advisors are employed by firms that manufacture and distribute financial services products, the unhealthy incentives of such vertically integrated companies can still result in substantially conflicted advice and consumer harm. As a result, a Royal Commission has been formed in Australia to investigate the matter further, with scathing reports finding that 90% of advisors at such vertically integrated firms were still giving conflicted advice that failed to meet a best interests standard. Romic suggests that the more fundamental problem is that for decades, the industry's advice model has typically bundled planning advice and product advice together, and regulation overseeing "advice" has failed to make a proper distinction between the two, effectively allowing product advice within product firms to drive the entire advice landscape (in an unhealthy manner). In Australia (and arguably in the US as well), this effort has been compounded by the way that the large firms have built out technology "platforms" for advisors, binding advisors to them in search of technology who would then subsequently be "straitjacketed" into selling their products (even if the advisor wanted to do the right thing), effectively using that technology as a form of captive distribution channel. Unfortunately, though, the path forward from here isn't entirely clear. Some are suggesting that the financial advisor/financial planner titles need to be better controlled in Australia, to more clearly distinguish advisors versus salespeople to the public, while others are calling for the elimination of even existing trails (though it's not clear how the consumers previously sold products will be serviced if their advisors' trail compensation is eliminated), and some are even calling for a preferred tax treatment for advisors who give fee-only advice with no separate product remuneration. The key point, though, is simply that just as Australia was one of the first to implement fiduciary reforms for advisors in the past decade, they now may become one of the first to formally drive a wedge between and force a separation of product advice from actual planning advice... which, again, could have profound implications if the trend expands globally (as their prior round of fiduciary reforms did).
The Future Of Financial Advisor Must Be More Diverse (Nick Richtsmeier, Wealth Management) - Despite the growing volume of articles being written about the need for diversity in the industry, coupled with more and more wealth management firms launching various diversity initiatives, the actual diversity of the financial services industry (and financial advisors in particular) remains stubbornly fixed... which raises the question of whether the industry is failing to properly consider and identify the root causes of its lack of diversity in the first place. For instance, the traditional mantra of the industry is something to the effect of "Financial success is derived from having a fixed set of goals funded as a consistent percentage of income into stock-market-based accounts". Yet Richtsmeier notes that in practice, women tend to be more non-linear thinkers that more proactively combine and shift amongst priorities of work, family, and philanthropy... suggesting that the traditional industry approach to goals might not actually be as gender-neutral as believed. Similarly, young people today are more likely to be engaged in the gig economy, don't have the same depth of company defined benefit plans, and in general have less stable incomes and less stable expenses as life changes occur... suggesting that the industry's traditional "save a fixed percentage of income" approach may similarly have a built-in (and largely unrecognized) age-bias that reduces its relevance and usefulness to next generation clients. And the traditional approach that "financial success is driven by investing into stock-market-based accounts" similarly fails to recognize that in many communities of color, it's hard assets like real estate – not intangible ones like stocks – that are believed to have greater reliability (and symbolic affluence), which suggests there may be a built-in ethnic bias as well. The fundamental point: it's not enough to simply say "how do we hire and promote more women/people of color/Millennials/Gen Xers", if we don't first address how our traditionally defined views of "success", potentially biased by our own business models, that necessitate this save-into-a-brokerage-account-centric approach, may be limiting our industry's relevance to and effectiveness in serving those more diverse populations in the first place.
I hope you enjoyed the reading! Please leave a comment below to share your thoughts, or make a suggestion of any articles you think I should highlight in a future column!
In the meantime, if you're interested in more news and information regarding advisor technology, I'd highly recommend checking out Bill Winterberg's "FPPad" blog on technology for advisors as well.
